The Merchants Trust

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  • 10 mins 29 secs
Simon Gergel, Portfolio Manager, Allianz Global Investors, gives an update on how The Merchants Trust is currently performing and discusses how the current investment landscape stands.

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PRESENTER: Joining me now is Simon Gergel, Portfolio Manager of the Merchants Trust, to give an update on how the investment company is performing, and also how the current investment landscape stands. So, Simon, good to have you back with us today. So just how challenging is the investment environment at present for UK stock pickers?

SIMON GERGEL: Well I think it’s quite a good environment actually because many UK companies are trading at quite reasonable long-term valuations. So there’s plenty of investments we can find which should deliver a good return in the long term. And on top of that there’s quite a lot of volatility. So we see occasionally some really good bargains as shares get depressed, and we’re able to take advantage of that, so I think for a stock picker it’s quite an interesting environment.

PRESENTER: And UK domestically-focused stocks, are these doomed in the short term or do they perhaps represent an opportunity?

SIMON GERGEL: Well I think the stock market or the general investment community has taken a view on the UK, which has led to many domestically focused companies being extremely lowly valued compared to their history. Now that can be an opportunity. Some of those companies are perfectly good businesses, will be around for a long term, and will get through. Even if there is a disruption associated with Brexit, many of those companies are still very strong and will be decent businesses and make good investments. There’ll be one or two that clearly might be more vulnerable. So the question for us is how do we separate companies that are fundamentally sound and very attractive, from the others where they might be a bit more vulnerable if there is an economic shock. So I wouldn’t say every company is perfect, but equally I wouldn’t say they’re all doomed either.

PRESENTER: Now corporate appetite for UK PLC does seem to be buoyant at the moment with bids and takeovers in the news. What are they seeing that we’re not?

SIMON GERGEL: I think companies take a longer-term view ironically than investors sometimes. And if you’re a business in an industry, and you know that one of your competitors is potentially trading at a valuation that is really unusual and very attractive, that can be a great opportunity. So because foreign investors have shunned the UK, because UK companies’ valuations are quite low, you are seeing many companies come in to try and buy up competitors and consolidate their industry at attractive prices. So I think it’s just a natural function of the market really.

PRESENTER: Now Merchants is a UK-focused trust, so how do investors in the trust gain global exposure?

SIMON GERGEL: Well the great thing about the UK stock market as you’ll know is it’s dominated by international earnings. So the vast majority of revenues and profits, both within the market and also within our portfolio, come from abroad. So you get exposure within the UK. You get very strong standards of corporate governance, of stewardship, protection of minority investors in the event of a takeover for example. But you get all of that with exposure to industries and markets around the world, so it’s a good combination.

PRESENTER: And what do you think attracts large multinationals, the global players if you like, to the UK?

SIMON GERGEL: I think it’s partly those high standards of governance and stewardship, which means that having a premium rating on the UK is admired internationally. I think also the time zone where the UK market happens to be, our legal system. The infrastructure in the UK for companies and for businesses is very strong, and we have a great reputation as a trading nation, an outwardly focused nation, being a good home to corporates to list.

PRESENTER: But do you think this could perhaps be under threat because of Brexit?

SIMON GERGEL: Well I think in the short there’s a lot of uncertainty, but I think long term we will get through this one way or another. And I think the UK will remain a great place to be based for businesses, particularly for those that have a global view.

PRESENTER: Well we do find ourselves in these uncertain times, but the UK does seem cheap right now. So is this a good time to invest in the UK?

SIMON GERGEL: I think it’s a good time on a long-term view. Clearly there are uncertainties and risks in the economy. There always are to be honest. There’s never a time when it seems like things are fine from an investment point of view. But the valuations of many businesses are sensible, and if you invest at sensible prices in good companies you should make a decent long-term return, albeit it can be volatile.

PRESENTER: Well we have discussed previously about the dividend status of the Merchants Trust, but which sectors would you say are offering the best yields and why?

SIMON GERGEL: There’s quite a lot of companies offering, sectors giving a good yield at the moment. So sectors such as life insurance, some of the utilities, a number of other areas, aerospace and defence, areas where we can find individual companies that are offering a combination of a good yield but also attractive valuations and decent long-term growth. We’re never looking just for a dividend yield; we’re always looking to marry that with a company that we believe is fundamentally strong and can deliver reasonable growth in the long term. So those sectors and several others actually offer good opportunities at the moment.

PRESENTER: Now Merchants dividend payouts have consecutively increased for 36 years, is this sustainable?

SIMON GERGEL: Well it’s a key focus of both myself as fund manager but also the board of directors, who are independent of the fund manager, and a key focus is growing the dividend sustainably. We’re very fortunate in the way investment companies work that the directors can tuck money away into reserves in good times, to continue to grow dividends in tougher times. So I think at the moment we have very substantial dividend reserves in the company. If we were to hit a more difficult period there would be plenty of buffer to maintain dividends for quite a long time. And at the same time we’re also benefiting from growth in the portfolio companies, in their earnings, in their dividends on an underlying basis. And we’ve also refinanced the debt which has given us an extra boost on the income. So at the moment the income flows in the portfolio are very strong, and we have this strong reserve position as well.

PRESENTER: But what would happen if companies did slash dividends, as we saw after the 2008 financial crisis?

SIMON GERGEL: Well I think that’s where the reserves come into play. But also we have a diversified portfolio, and as I said earlier we have exposure to industries and companies around the world on a diversified basis. So we would hope that even if you get certain industries under pressure, that the vast majority of companies would still be able to maintain and grow their dividend payments. But in a worst scenario we do also have those dividend reserves, so that gives enormous comfort hopefully.

PRESENTER: Now last time you were on we did discuss the refinancing of the Merchants Trust loan, which was originally taken out in 1987. So now we’re in this low rate environment what advantage is that for investors?

SIMON GERGEL: Well that’s right. We managed to replace quite expensive debt with 35-year borrowings at just under 3% cost. So we’ve taken the average cost of debt down from 8½% to around about 6%, which is a great advantage to investors because it means the earnings of the company, earnings per share are higher, and therefore the directors can if they want grow the dividend a little bit higher or step it up a bit from where it was. So that is an ongoing benefit year after year of lower costs going forward. Plus we have secured really long-term financing at what I think is a very attractive rate.

PRESENTER: Now looking a little bit as your asset allocation, you have recently bought back into the tobacco industry, so how does ESG fit into this?

SIMON GERGEL: Yes, we had a very long hard think about tobacco, because were out of it for at least a year. And clearly the ESG debate is a very important one, and there are I suppose two sides to it. One on the hand I think there are moves to healthier lifestyles, and you are seeing smoking prevalence decline. You’re seeing fewer people taking up smoking, and therefore as an investor you have to understand the implications for the cashflows of tobacco companies from reducing smoking prevalence. That’s the first side, and that’s relatively straightforward.

The second one is how will investors think about tobacco companies, will other investors decide not to own tobacco companies because of ESG concerns? That’s a more difficult one. I think we are probably in the state where the discount on tobacco companies will be higher than it previously was, because more investors are using those types of screens or thinking in those terms. And we factor that into our analysis, but we think even here there are one or two, one of the tobacco companies is particularly attractive even at this level, even allowing for ESG concerns.

PRESENTER: And your exposure to financials has edged up over the past few years, why would you say this is?

SIMON GERGEL: We are driven very much by the individual companies. So we are able to find a number of very different financial companies, which offer a combination of an attractive dividend yield, strong market position, and decent growth in cash flows and potentially dividends. And it’s really diversified. There are life insurance companies, asset managers, real estate companies. It’s not simply a view on banks for example, or one type of financial company. And therefore it’s, although they’re all classified as financials, in reality it’s many different business.

PRESENTER: Well finally over half of investment trusts have had the same manager for 10 years. Now you’ve been with the Merchants Trust for 12 years, so what sort of advantages do you think this represents?

SIMON GERGEL: That’s a good question. I think one of the great things about investment trusts is you have effectively closed-end capital. So as a fund manager you know that you can invest for the long term without fearing large redemptions from the portfolio, and having to make forced sales at what might be unattractive places. So for a fund manager it’s a good portfolio to run from that point of view. But also we’ve got a good working relationship with the board who are very challenging, but they’re very understanding after a long period of time of the way we invest and what we’re trying to achieve. And in addition we know many of the individual shareholders quite well, and some of the institutional shareholders, so we’ve got a good understanding what the shareholder wants.

So between the closed end structure, the independent board, and the shareholders, all of that helps if you’ve been around a while to run a trust. It all helps build an environment in which you can hopefully continue to do what we’ve been doing for 12 years, and the Merchants Trust has been doing for 129 years.

PRESENTER: Simon, thank you.

SIMON GERGEL: Thank you.
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